The ASC 606 transition for construction contractors: Recognizing revenue

The expanded scope of these accounting methods is a welcome change for many small taxpayers, resulting in reduced administrative burden, simplified accounting, and possibly a deferral of tax payments to future years. As the contract progresses, the revenues & expenses are accumulated in the balance sheet until the last day of contract completion. It is only after the completion of the contract that the figures are moved from the balance sheet to the profit & loss account. You can observe from the above reading that the disadvantages of this method are more than the advantages. Thus, if you want a better picture of the contract status, the percentage completion method of accounting is upheld in all accounting standards, tax laws, etc.

Additionally, the „taxpayer“ referred to in the test includes any predecessor of the taxpayer. C corporations, partnerships with C corporation partners, and tax shelters are prohibited from using the cash receipts and disbursements method of accounting under Sec. 448(a). However, a C corporation completed contract method or a partnership with a C corporation partner may use the cash method if it meets the Sec. 448(c) gross receipts test. The gross receipts test is satisfied for a tax year if a taxpayer’s average annual gross receipts for the prior three tax years do not exceed $25 million.

1. In the contract, the organization has given an offer of $5 million that is willing to pay ABC once they complete the project.
2. Also, since revenue recognition is postponed, tax liabilities might be postponed as well.
3. In addition to the completed contract method, another way to recognize revenue for a long-term contract is the percentage of completion method.
4. Large contractors, who have an AAGR exceeding $10,000,000 for the prior three years, are required to report long-term contracts on POC for tax purposes.
5. A C corporation taxpayer or a partnership with a C corporation partner could not use the cash method if it failed the aforementioned $5 million gross receipts test of Sec. 448(c) for any prior tax year.

For example, if a company needs to apply for credit from a bank, it may be challenging to prove how much revenue the company generates using the completed contract method. The Sec. 263A uniform capitalization (UNICAP) rules apply to taxpayers that maintain inventories. The TCJA exempts any producer or reseller that meets the gross receipts test from the application of UNICAP. An elevator contractor enters into a contract to remove an existing elevator and replace it with a new elevator in a commercial building for $4 million.

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Under previous guidance, Treasury and the IRS anticipated that larger businesses might attempt to meet the former $5 million gross receipts test by separating activities into multiple entities to fall beneath the threshold. Generally, the aggregation rules apply to entities that are members of a controlled group with more than 50% common control or are considered affiliated service groups (Secs. 52(a) or (b) and 414(m) or (o)). When using the completed contract method, it is important to plan and keep a focus on your backlog. Having a backlog helps maintain or increase a deferral, while running out of work will cause the taxpayer to recognize the total deferral. There are typically three requirements that must be in place to proceed with a percentage of completion method. These are a contract that specifies the milestones and payments, assurance that a buyer can ensure payment, and that a seller can ensure completion.

In practice, this means you won’t record any expenses or revenues as the project progresses, even if you buy materials or receive compensation from the project owner. One of the most significant advantages of percentage of completion is that you can get a view on profitability before the job is complete. Another benefit is that you don’t have to wait until the end of a project to receive payment. Additionally, you can avoid a heavy cost https://personal-accounting.org/ hit at the start of the job since you won’t need to front the entire project as you’ll be receiving payment along the way as you progress through the job. If you can handle your cash flow tactfully, you can keep dollars flowing in without waiting for everything to wrap up. The percentage of completion method requires the use of progress invoices–a billing document used to bill for partial project completion as you complete work.

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The procedures for requesting a change in accounting method are discussed later in this article. Though a construction company may enjoy a break from taxes during the working phase—and sometimes may even qualify for certain tax incentives in the meantime—this method can be a riskier way to account for operations. We are a subcontractor and the GC we are working for is asking us to sign and notarize progress payment line waivers for amounts they have not paid us for, is this legal?

Although the cash method might be straightforward, it can delay recording revenue and expenses until the money is earned or paid out. For example, let’s say you won a contract to build a fence with a total contract price of $5,000 with net-60 payment terms. If you complete the fence in July, you’ll record $5,000 in revenue in July because that’s when you earned that revenue. Even if you receive payment 30 days later in August, you’ll still record the revenue from this job in July to reflect when you physically built the fence and earned payment.

Still, even with these risks, the completed contract method is the most conservative accounting method for companies working on long-term contracts. If a project won’t be completed until the following year, the company won’t have to pay tax on that revenue this year. Additionally, the completed contract method is designed to prevent contractors from accidentally recording “phantom revenue” on more unpredictable projects — that is, earned income they thought they would get but may not end up collecting. Sec. 163(j) revisions increased the number of taxpayers that may have interest expense deductions disallowed. To determine small business status, a taxpayer must apply the complex Sec. 448(c) rules, evaluating predecessor history (if any) and its complete structure to determine if gross receipts from certain related entities must be aggregated.

Completed contract

If these requirements cannot be met then it is recommended to proceed with the completed contract method. For example, if a contract is set for completion in five years, the business may not incur taxes on that project’s income during that time. If tax rates were to increase during that period of five years, the company faces paying higher taxes than it would have if reporting occurred sooner in the process. As an additional bonus, this method eliminates the problem of estimating errors that can occur using the percentage of completion as a guidepost. There’s no need to estimate costs when using the completed contract method since those costs are readily apparent at the end of the contract.

Overbilling occurs when a contractor bills for contracted labor and materials prior to that work actually being completed. In 2025, the balance sheet activity for both years is moved to the income statement. If your company qualifies for the CCM and you are accounting for this type of contract for the first time, no special election is required. Companies should consult a tax professional before deciding which accounting method is best from a tax standpoint.

Completed Contract Method – Explained

It’s relatively easy to implement and gets the ball rolling with tracking cash flow. Under the completed contract method it is not necessary to estimate the costs of the project as all of the costs are known at the time the project is completed. Another risk using this system is that a contractor may have multiple contracts ending at the same time. This can cause a significant fluctuation of expenses and revenue in the balance sheet. To those outside the company, this could be seen as a sign of inconsistency and risk, which can make securing bonding or acquiring financing particularly tricky.

This method requires contractors to use a separate, dedicated balance sheet to record their expenses and revenues. Once the project is finished, the billings and costs will be pushed to their income statement. Even if payment is received through progress billings, those will not be factored into the final income statement until the end of the project. But, if the contractor becomes aware that the contract will end in a loss, it should be recorded on the income statement as soon as possible. Because income and expenses hit all at once, income statements become less useful in the short term and can show major, sudden swings.